What type of retirement account is best?Submitted by Private Client Advisory, Inc. on July 15th, 2016
If you work long enough, you'll get social security benefits. But for most people, that's not sufficient to cover all of your living expenses for the rest of life. So to know which retirement vehicle is right for you, you'll need to ask yourself a few questions.
1. Do you want to pay taxes now or later?
There are essentially two categories of retirement accounts: tax-deferred and tax-free.
With tax-deferred retirement accounts, you pay taxes when you pull money out, and (usually) get a tax deduction when you put money in.
Examples of tax-deferred accounts are:
- Traditional or Rollover IRA
- Traditional 401(k), 403(b) or 457(b)
With a tax-free retirement account, you lose the deduction for putting money in, but when you pull money out, it is tax-free.
"Tax-free" is a bit of a misnomer, though, because you will still have paid taxes on the amount you contribute; it's just the withdrawal part that is free of income taxes. (It should be called "taxed-already.")
Examples of tax-free accounts are:
- Roth IRA
- Roth 401(k)
Now, back to original question: Do you want to pay taxes now or later?
If you think your personal tax rate will be higher in retirement, then you should consider paying taxes now and employing a tax-free account.
If you think your taxes will be lower, then it might make sense to get a deduction now and pay the taxes later while in a lower bracket.
What we will often recommend is a combination of the two. Think of it like a faucet with two knobs--a tax-free knob and a tax-deferred knob. If taxes are getting too hot, then turn down the "deferred" knob and turn up the "free" knob.
Of course, it's not an exact science, but you get the idea. We think it makes sense to have both, so you have options down the road.
2. Does your employer match your contributions?
We all know there's no such thing as a free lunch, but when your company makes a matching contribution on top of what you put into your employer-sponsored retirement plan, it's pretty close.
Examples of employer-sponsored retirement plans include:
- Simple IRA (note that with a SIMPLE IRA the account is in your name only, but it is funded by your employer)
Not every company retirement plan includes matching, and when they do it often looks something like this: they match 50% of what you contribute up to 6% of your salary. So, for example, if your salary is $100,000 and you defer 6% ($6,000) into your 401(k), your employer would then match 50% and add $3,000 on top of your $6,000 for a total of $9,000 going into your account.
3. Have you maxed out?
There is a limit to how much you can contribute to retirement accounts.
[The IRS keeps their website updated with the contribution limits for retirement accounts.]
So, once you've reached your contribution limit for the year, here are a few options to consider:
- open a non-deductible IRA
- make after-tax contributions to your company plan (if allowed)
- start a regular non-tax favored investment account and buy tax-friendly investments
There is a lot to consider when deciding what retirement account is best. Frankly, there is no "best"; there is only making an informed decision about what works for you.
So, if you would like help from a seasoned professional, reach out via the Contact Us page or call (770) 297-9000 and schedule a 15-30 minute "get acquainted" phone appointment.
Please note that we will be delighted to work with your accountant, together for your benefit, but we do not provide tax or legal advice.